Euro zone moving from economic to political crisis

Washington's political stunts and Italy's government crises are nothing new. But what looks like a difficult search for a governing coalition in Germany, and, possibly, another round of parliamentary elections, could soon be a sight to behold.

Last Friday, the 250 delegates of the German Social Democratic Party (SPD -- with 25.7 percent of the popular vote in last elections) gave the mandate to their leadership to open exploratory coalition discussions with Chancellor Merkel 's Christian Democrats (CDU), who got 41.5 percent of the vote and were only 5 seats short of the absolute parliamentary majority.

Reflecting a deep cleavage between the SPD's base and its leadership, the negotiating mandate came with a tough rider.

First, SPD leaders will have to report to the party delegates on the results of these initial discussions, likely to begin this week. And then, should these contacts lead to formal negotiations, the party leaders would have to obtain the delegates' authorization on the terms under which the SPD would accept to participate in the future government.

In the end, the coalition agreement, if there is one, would have to be submitted to an SPD referendum, clearly implying that leaders would have to resign if disavowed by the party vote.

Germany's red-green-red coalition?

One of them already did: Peer Steinbrueck, the SPD's candidate for chancellor in last elections, and the finance minister in the CDU-SPD coalition government from 2005 to 2009, has emphatically refused to participate in negotiati––ons with CDU.

I don't believe that this is part of the usual political posturing. The rift is serious, and widening, between the current SPD party leaders – who fear their own political oblivion – and the party base apparently unafraid to stay in the opposition and to fight for renewal on the strength of their traditional values and beliefs.

Is there any scope for a CDU-SPD agreement?

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I think there is. The recent election campaign had shown that these two parties were not too far apart on key issues, such as the minimum wage, maximum tax rates, renewable energy, retirement age and pension regulations, euro area policies and part-time employment.

The parties' positions are diverging on three issues: family policy (including regulations for same-sex marriages), health care and double nationality. Apparently, none of these look like the ultimate deal-breakers.

Where does this leave the CDU?

If it is true that a coalition partnership with the Green Party (8 percent oftotal votes) is impossible, the CDU would either have to (a) give more than SPD should get on the basis of its election results, and get ready to govern with a difficult and bitter rival for the next four years, or (b) opt for a new round of elections in the hope of getting an absolute majority.

All of this, however, glosses over a very simple fact: Germany already has a center-left coalition of SPD, Greens and the Left Party (Die Linke) that could form the government with absolute majority of 319 seats in the lower house of parliament with a total of 630 seats.

That would also clinch this coalition's total control of both chambers of the parliament, because the SPD and Greens already have a majority of 36 votes (out of a total of 69 votes) in the upper house.

One does not see much about this in the German media, even though the SPD and Greens have ruled the country from 1998 to 2005. The main problems here are apparently old enmities between the leadership of SPD and Left Party, because this far-left political entity (set up in 2007) is populated by former SPD members who were dissatisfied by SPD's centrist stance on key issues of social governance.

In spite of that, I believe that the possibility of this center-left coalition bears watching. If the CDU and SPD coalition talks were to hit the wall, these three center-left parties know that a new round of elections would not be a good idea for them.

Italy ungovernable; France's ascending far-right

Italy,however, can't avoid another election. The government collapsed on Saturday, September 28, 2013, after the resignation of five cabinet members from the People for Freedom Party (Forza Italia), controlled by the former Prime Minister Silvio Berlusconi.

The country's President Giorgio Napolitano will probably try again to put together some sort of coalition of questionable longevity. But this time that might be impossible unless a deal can be struck to avoid expelling Mr. Berlusconi from the Senate, where the first vote on that is due on October 4,2013.

Otherwise, he has to serve a one-year jail sentence (under house arrest or in community service) on tax fraud charges.

Italian political ingenuity is not beyond such a deal, particularly since new elections would almost certainly not yield a stable government. In that case, the president would again have to bring together parties with incompatible political programs into some sort of coalition agreement.

Trichet: Need progress on Europe's banking union

Jean-Claude Trichet, Former president of the European Central Bank says euro zone officials must decide on a single authority to handle the region's 'bad banks' as soon as possible.

France is not facing new general elections until early 2017. However, a deeply unpopular government, with an approval rating of 23 percent, one of the lowest in the post-WWII period, has given rise to a splintering political landscape,spanning the entire spectrum from far-right to far-left.

The government's support in its constituency of greens and far-left parties is crumbling, while the far-right National Front is gaining ground on the more moderate center-right opposition groups.

The upshot is that while the weak Socialist government seeks to manage popular discontent, the fiscal consolidation has been slowed down, and politically divisive structural reforms of labor markets and welfare state are studiously avoided.

That is all part of the euro area's post-austerity drive, and is probably as much as the government can do without risking social unrest. But that is still not enough for the government's supporters – the greens and the far-left – who want stronger measures in favor of growth and employment.

The squeeze is also coming from the far-right. This political constituency getting 16 percent of the votes in the latest opinion survey is railing against the German-dominated euro area and the single currency.

Investment implications

The euro is safe. The European Central Bank (ECB) stands ready to provide emergency backstops and easy credit terms to support the incipient euro area recovery.

The troika – the EU Commission, the ECB and the IMF – manages the conditional lending to Cyprus, Greece, Ireland and Portugal. All of these countries are making slow progress, with Portugal's economy rebounding strongly in the second quarter on rising export sales. Spain is also edging out of recession. Italy's downturn is moderating, and its budget deficit this year is expected to stay below 3 percent of GDP.

A protracted period of Germany's coalition talks, or another round of general elections, would not significantly affect the country's economic policies, but that could slow down some euro area initiatives, such as the banking union or measures of regional and sectoral support to promote growth and employment.

The recovering euro area remains an attractive investment destination.